NEW YORK/SYDNEY/LONDON Goldman Sachs Group Inc's metals warehousing unit is exploring its first foray into China, and privately held C Steinweg has expanded capacity there, sources said, as a financing scandal in a major Chinese port fuels a scramble for market share.

The alleged scam - in which a Chinese trading firm is suspected by local authorities of fraudulently using a single cargo of metal as collateral for multiple loans - has shaken the confidence of banks and merchants in Western metals storage firms that rely on local agents to oversee warehouse operations.

It has intensified a battle between new entrants and entrenched rivals in the multi-billion dollar business of securely storing the world's commodities in China, the world's biggest producer and user of base metals.

As Goldman ponders a possible move into China, Western warehousing companies already operating there, including Glencore Plc unit Pacorini Metals and Trafigura-owned Impala [TRAFGF.UL], are scrambling to defend their turf.

They are looking at ditching local agents in favor of setting up their own domestic operations to oversee warehousing assets directly, seven sources who work for warehousing companies or use them to store their metal said.

Detroit-based Metro International Trade Services, a major warehousing company that Goldman bought in 2010, is looking at setting up shop in Shanghai and other bonded locations in the country, a source familiar with the matter told Reuters.

"Western banks and other types of financiers want an alternative to what's already there," the source said.

A spokesman for Goldman declined to comment. The possible move comes at a critical time for the bank. It is looking to sell Metro amid pressure from U.S. regulators and lawmakers, who are concerned about Wall Street banks' involvement in the physical commodities market.

The investigation by police in the Chinese port city of Qingdao centers on a private metals trading firm, Decheng Mining, and its related companies that allegedly used fake warehouse receipts for about 340,000 tonnes of copper, aluminum and alumina, the key ingredient for making aluminum.

Western banks including Standard Chartered, Citigroup Inc, Standard Bank Group, and merchants including Mercuria have disclosed exposure amounting to almost $1 billion.

Following the revelations, banks and traders with metal in Qingdao and elsewhere in China have raced to check the metal actually exists, move it into depots considered more secure and protect themselves from potential losses, sources said.

With banks facing hefty losses and financing terms in China tightening, it's not clear if these steps by the warehousing industry to repair the damage will be enough to restore confidence in the long term.

"This (scandal) is changing the nature of the warehousing business significantly. Using third parties is not a viable model anymore," said a source at a major merchant that has metal stored in China.

EXPANDING FOOTPRINT

Steinweg, a 167-year-old Rotterdam-based firm, is looking to expand its vast footprint in China by leasing more sheds in Qingdao, as well as Shanghai and other locations in China, two sources familiar with the move told Reuters.

Unlike some rivals, Steinweg carved out a niche in the burgeoning China market by operating and controlling its own depots, rather than using local agents, sources have said.

The company leases storage space, often located in free-trade-zones in ports, and has its own staff to monitor the stock itself.

More than 100,000 tonnes of copper has already flowed into its sheds from rivals' depots since the scandal broke, one of the sources said. That is equivalent to about one-fifth of all the copper stockpiles estimated to be held in bonded storage in Shanghai, and nearly as much as the London Metal Exchange's global inventories.

The company declined to comment on the expansion. It operates in 11 locations in China, according to its website.

Goldman's Metro unit would likely copy the Steinweg business model of running and controlling its own sheds if it decides to make a move into China, sources say.

For now, Steinweg's model appears to have paid off as skittish banks and merchants pressure warehouse operators to prove there is no chance of their stockpiles getting mixed up with other customers' metal.

Other warehouse companies are scrambling to catch up. They include CWT Commodities owned by CWT Ltd, Pacorini Metals, Impala, Henry Bath owned by JPMorgan Chase & Co, and GKE Corp, which is a unit of Louis Dreyfus Corp [LOUDR.UL].

Sources familiar with their plans said they were either stopping using local firms and hiring their own staff to run their sheds or were considering doing so.

JPMorgan is in the process of selling its physical commodities business, including the warehousing unit, to Mercuria.

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